Tax law has changed significantly each year beginning in 2017 with Tax Cuts and Jobs Act, followed by Cares Act, Consolidated Appropriations Act, ARPA, Infrastructure Investment and Jobs Act, Inflation Reduction Act the Secure Act, 2.0 .

Historically, businesses could immediately deduct research and development (#R&D) expenses in the year they were incurred, encouraging innovation and investment in new technologies.

The Tax Cuts and Jobs Act (TCJA) of 2017 introduced a significant change affecting this deduction: the requirement to amortize R&D expenses over five years, or fifteen years for research conducted outside the U.S., starting from the midpoint of the tax year in which the expenses were paid or incurred. This change, effective for tax years beginning after December 31, 2021, represents a departure from previous tax treatment and challenges businesses engaged in R&D activities.

The requirement to amortize R&D expenses affects cash flow and financial planning for businesses. Immediate expensing allowed companies to reduce their taxable income in the year expenses were incurred, providing an immediate cash benefit. Amortization delays this benefit, potentially reducing investment in R&D due to tighter cash flow, especially for startups and small businesses that are more sensitive to cash flow constraints.

Additionally, this change complicates tax planning and increases administrative burdens. Companies must track R&D expenses over the amortization period, adjusting for changes in their R&D investment strategies. This complexity adds to the cost of compliance and may divert resources away from productive R&D activities.

In response to concerns raised by the business community and tax professionals, bipartisan bills have been introduced in both the House of Representatives and the Senate aiming to repeal the amortization requirement. If enacted, these bills would allow companies to continue fully deducting #R&D expenses in the year they are incurred, maintaining the United States’ competitive edge in innovation and technology development.

Early in 2024, a glimmer of hope emerged with the proposal of the Tax Relief for American Families and Workers Act, aimed at reversing these changes. However, the failure of the Tax Relief for American Workers and Families Act to pass in the Senate adds to the uncertainty surrounding the tax treatment of R&D expenses. Without legislative change, the current requirements under Section 174 will persist, necessitating the amortization of R&D expenditures over the stipulated periods. This could significantly impact your business’s financial planning and tax liabilities.

Implications:

If you are engaged in R&D activities, it’s crucial to stay informed about these developments and plan accordingly. The persistence of the amortization requirement under Section 174 may necessitate adjustments to your financial strategy, particularly in terms of cash flow management and tax planning.

Despite the uncertainty, there is a silver lining for small businesses in the form of the Research and Development (R&D) Tax Credit. This credit remains a valuable incentive, especially for startups and small businesses, as it has been made more accessible through recent legislative changes.

The R&D Tax Credit for Small Businesses:

For tax years beginning after December 31, 2015, qualified small businesses can elect to apply a portion of their R&D tax credit against their payroll tax liability, up to a maximum of $250,000 ($500,000 after December 2022). This provision, part of the Protecting Americans from Tax Hikes (PATH) Act, is particularly beneficial for startups and small businesses that may not have a significant income tax liability but still incur substantial payroll expenses.

To qualify, a business must have less than $5 million in gross receipts for the tax year and no gross receipts for any tax year preceding the five-tax-year period ending with the tax year.

As your accounting partners, we understand the complexities and challenges the current legislative environment poses. We are committed to keeping you informed and providing strategic advice tailored to your situation. Whether you’re currently engaged in #R&D activities or planning for future innovation, we can help you navigate the tax implications and explore all available options to optimize your financial position.